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Fed’s Yellen effectively takes negative rates off table

WASHINGTON (MarketWatch)—Federal Reserve Chairwoman Janet Yellen on Tuesday defended the U.S. central bank’s decision to move cautiously on interest-rates hikes given the risky outlook, as she also revealed the tool kit in case the economy stumbles.

“Global developments have increased the risks” to the outlook, with economic and financial conditions still less favorable than in December when the Fed engineered its first rate hike in a decade, Yellen said in a speech to the Economic Club of New York.

“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy,” she said. She didn’t mention a month for when the Fed could lift interest rates.

Investors welcomed Yellen’s go-slow approach. Many analysts said her remarks meant the Fed wouldn’t consider a rate hike at the next policy meeting in late April.

Stocks moved higher after Yellen’s spoke. The S&P 500 index SPX, +0.88% was up 18 points at 2,055 in late-afternoon trading, touching their highs of the session.

“The bottom line is that the Fed is going to go very slowly and cautiously,” said Ward McCarthy, chief financial economist at Jefferies LLC, adding he was struck by the “pessimism, lack of confidence and uncertainty-laden tone” of Yellen’s remarks.

The Fed Chairwoman said the overall fallout from market turmoil in the first seven weeks of 2016 will most likely be limited, but said this was still uncertain. In total, she mentioned the work “risk” 19 times in her speech.

The Fed chairwoman repeated her doubts that the pickup in core inflation since the beginning of the year was the start of an upward trend, but warned against reading too much into an uptick in inflation.

“It is too early to tell if this recent faster pace will prove durable,” Yellen said.

In an unexpected twist to the speech, Yellen pushed back on the conventional wisdom that the U.S. central bank would be virtually powerless to respond to a recession given that interest rates are so close to zero.

“The Fed would still have considerable scope to provide additional accommodation,” Yellen said.

The Fed could make promises, or what she calls “forward guidance” on interest rates, she said, and mentioned the possibility of buying more bonds or exchanging short-term bonds for longer-dated ones.

To pull the economy out of the financial crisis, the Fed bought government securities in three separate tranches that collectively expanded its balance sheet by close to $3 trillion. The program, known as quantitative easing, or QE, was an attempt by the central bank to push investors to buy riskier assets. It also boosted the price of financial assets.

In addition, the Fed executed a plan, dubbed Operation Twist, to push long-term interest rates lower by selling short-term securities on its books and using the proceeds to buy longer-term securities. The central bank eventually purchased, as well as sold or redeemed, $667 billion in Treasurys through this program.

Yellen made no mention of negative interest rates as a possible response. Other major central banks, including the European Central Bank and the Bank of Japan, have pushed rates below zero.

Suggestions by Yellen and others that the Fed would consider such a move have generally been taken as a sign of desperation by Wall Street.